Saturday, December 20, 2008

Twenty-five years ago, along with another young journalist, I coauthored a book called California, Inc. about our adopted home state. The book described “California’s rise to economic, political, and cultural ascendancy.”

As relative newcomers at the time, we saw California as a place of limitless possibility. And over most of the next two decades, my coauthor, Paul Grabowicz, and I could feel comfortable that we were indeed predicting the future.

But much has changed in recent years. And today our Golden State appears headed, if not for imminent disaster, then toward an unanticipated, maddening, and largely unnecessary mediocrity.

Since 2000, California’s job growth rate— which in the late 1970s surged at many times the national average—has lagged behind the national average by almost 20 percent. Rapid population growth, once synonymous with the state, has slowed dramatically. Most troubling of all, domestic out-migration, about even in 2001, swelled to over 260,000 in 2007 and now surpasses international immigration. Texas has replaced California as the leading growth center for Hispanics.

Expansion of homeownership could be a sound policy, especially for low-income families and members of minority groups. The social benefits of homeownership have been extensively documented; they include stable families and neighborhoods, reduced crime and delinquency, higher living standards, and less depreciation in the housing stock. Under these circumstances, the policy question is not whether homeownership should be encouraged but how the government ought to do it. In the United States, the policy has not been pursued directly--through taxpayer-supported programs and appropriated funds--but rather through manipulation of the credit system to force more lending in support of affordable housing. Instead of a direct government subsidy, say, for down-payment assistance for low-income families, the government has used regulatory and political pressure to force banks and other government-controlled or regulated private entities to make loans they would not otherwise make and to reduce lending standards so more applicants would have access to mortgage financing.

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Many culprits have been brought before the bar of public humiliation as the malefactors of the current crisis--unscrupulous mortgage brokers, greedy investment bankers, incompetent rating agencies, foolish investors, and whiz-kid inventors of complex derivatives. All of these people and institutions played their part, of course, but it seems unfair to blame them for doing what the government policies were designed to encourage. Thus, the crisis would not have become so extensive and intractable had the U.S. government not created the necessary conditions for a housing boom by directing investments into the housing sector, requiring banks to make mortgage loans they otherwise would never have made, requiring the GSEs to purchase the secondary mortgage market loans they would never otherwise have bought, encouraging underwriting standards for housing that were lower than for any other area of the economy, adopting bank regulatory capital standards that encourage bank lending for housing in preference to other lending, and adopting tax policies that favored borrowing against (and thus reducing) the equity in a home.

As a result, between 1995 (when quotas based on the CRA became effective during the Clinton administration) and 2005, the homeownership percentage in the United States moved from 64 percent, where it had been for twenty-five years, to 69 percent; in addition, home prices doubled between 1995 and 2007. In other words, the government is responsible for the current crisis in two major respects: its efforts to loosen credit standards for mortgages created the housing bubble, and its policies on bank capital standards and the deductibility of interest on home equity loans made the current crisis inevitable when the bubble collapsed. This Outlook will explore the strong relationship between the intervention of the U.S. government in the housing market and the worldwide financial crisis that has resulted.

Tuesday, December 16, 2008

Mickey Kaus, pretty much alone among the commentators I've been reading, indicts "Wagner Act unionism" for the decline and fall of the U.S. auto industry. The problem, he argues, is not just the high level of benefits that the United Auto Workers has secured for its members but the work rules—some 5,000 pages of them—it has imposed on the automakers. As Kaus points out, unionism as established by the Wagner Act is inherently adversarial. The union once certified as bargaining agent has a duty not only to negotiate wages and fringe benefits but also to negotiate work rules and to represent workers in constant disputes about work procedures.

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The UAW also created a constituency within itself of retirees who have voting rights in union elections just as actual workers do, and there are now something like three times as many GM retirees as GM employees as voting members of the UAW. Retiree benefits account for the lion's share of the difference between GM's labor costs and the labor costs of foreign automakers in the United States.

General Motors in 1970 thought it could afford this. Didn't it "control" half the U.S. auto market? Couldn't it generate any level of demand it wanted through advertising? That's what as learned a sage as John Kenneth Galbraith had argued in his bestselling The New Industrial State, published in 1967. GM in 1970 didn't fear competition; its greatest fear was that the Justice Department would bring an antitrust case to break it up.

But of course it turned out that GM and Ford and Chrysler were in 1970 just on the verge of getting serious competition from foreign automakers.

In a recent article for Vanity Fair, Stiglitz engaged in falsehoods and contradictions in order to blame capitalism for our present troubles. It would perhaps be better for him and other elite economists to simply look in the mirror.

Indeed, while Alan Greenspan’s light trashing of free markets has surely earned him a place in economic purgatory, the blame being passed his way for the housing boom and bust is not rooted in reality. Many even on the Right blame low nominal rates of interest on Greenspan’s watch for the latter, but then history shows housing has traditionally done best when interest rates are rising.

More realistically, weak currencies are the biggest drivers of nominal home-price gains, and for evidence we need only study Richard Nixon’s second presidential term and Jimmy Carter’s lone term to find that much like this decade, housing was frothy under both. Stiglitz argues that Greenspan had a role here for turning on “the money spigot” with “full force” earlier in the decade, but then money supply is vastly overrated as an indicator of a currency’s direction. For evidence, we need only compare the ‘70s and ‘80s when money creation by the Fed was the same, but achieved opposite results. If Stiglitz is looking for someone to blame here, he would do better to finger a Bush Treasury that embraced a weak dollar with great vigor.

Stiglitz says Greenspan should have been more vigilant about curbing “predatory” lending to low-income households and “liar loans”, but when we consider how the Right talked up “America’s Ownership Society” in concert with politicians from the Left eager for Fannie and Freddie to expand their mandate into the subprime space, it seems folly to assume that Greenspan could have blunted this bipartisan bout with political correctness. Stiglitz decries the innovation that made these loans possible, but then loans are always risky, and they’re only problematic when the very regulators and politicians whose actions he espouses seek to privatize the gains from same, while socializing the losses.

While he served President Clinton, Stiglitz claimed he did not support the repeal of Glass-Steagall, and that repeal changed the culture of banking, thus making way for the various failures in our midst. What he ignores is that with the exception of Citigroup, the majority of financial failures involved investment banks lacking a commercial-bank affiliation. Indeed, imagine what might have happened if regulations had kept commercial banks from serving as White Knights in this whole financial mess (see J.P. Morgan & Bank of America), and more broadly, what a shame that regulations kept other cash rich companies such as Wal-Mart from buying greatly weakened financial institutions in order to enter the banking space themselves.

Stiglitz regularly seeks to elevate regulation as the path to financial health, but then contradicts himself in decrying a 2004 SEC decision in which investment banks were allowed to increase their debt-to-capital ratios “from 12:1 to 30:1, or higher”. The question Stiglitz fails to ask is whether regulation was in fact the problem. Indeed, the ’04 SEC decree essentially allowed risk-oriented banks to hide behind the very regulations that Stiglitz would like more of. Did it ever occur to him that absent a muscular SEC, self-interested investors with their money on the line might have regulated the investment banks themselves; allowing firms with a history of investment success higher debt-to-capital ratios, while curbing the activities of those thought to be unworthy?

On the tax front, Stiglitz claims that the 2001 and 2003 Bush tax cuts “played a pivotal role in shaping the background conditions of the current crisis.” According to him, “they did very little to stimulate the economy.” About the 2001 “reductions”, he would have a point in that stimulus and tax breaks for select industries are by definition an economic retardant. But there again lies a contradiction in that while he correctly decries the imposition of Henry Paulson’s awful TARP, his reasoning has to do with Paulson’s failure to do anything “about the source of the problem, namely all those foreclosures.” Put simply, Stiglitz didn’t like the welfare that characterized Bush's Stimulus I, but somehow welfare for irresponsible homebuyers is a good thing.

Regarding the ’03 cuts, if economic growth is the certain result of productive work effort bolstered by investment, and it is, how is it that lower penalties on both would harm ours or any economy? More important, Stiglitz contradicts himself again in noting the massive amount of “foreign” oil that reached our shores in subsequent years. Indeed, imports of any kind are merely a reward for productive economic activity. If the ’03 cuts had hurt the economy, this would have revealed itself through less, not more in the way of imports. Stiglitz would also do well to remember that we’re not “independent” when it comes to all manner of goods, but far from economically enervating, this lack of self-sufficiency is a positive for Americans mostly doing that which they do best. Put simply, self-sufficiency of the economic variety is merely a kind term for poverty.

President-elect Barack Obama's plan to stimulate the economy by increasing government spending was tried in Japan and led to Japan's "lost decade," in which the economy grew hardly at all. The Wall Street Journal editorial page recounts the details in their column titled Barack Obama-san

As January 20 nears, Barack Obama's ambitions for spending on the likes of roads, bridges and jobless benefits keep growing. The latest leak puts the "stimulus" at $1 trillion over a couple of years, and the political class is embracing it as a miracle cure.

Not to spoil the party, but this is not a new idea. Keynesian "pump-priming" in a recession has often been tried, and as an economic stimulus it is overrated. The money that the government spends has to come from somewhere, which means from the private economy in higher taxes or borrowing. The public works are usually less productive than the foregone private investment.

In the Age of Obama, we seem fated to re-explain these eternal lessons. So for today we thought we'd recount the history of the last major country that tried to spend its way to "stimulus" -- Japan during its "lost decade" of the 1990s. In 1992, Japanese Prime Minister Kiichi Miyazawa faced falling property prices and a stock market that had sunk 60% in three years. Mr. Miyazawa's Liberal Democratic Party won re-election promising that Japan would spend its way to becoming a "lifestyle superpower." The country embarked on a great Keynesian experiment:

August 1992: 10.7 trillion yen ($85 billion). Japan passed its largest-ever stimulus package to that time, with 8.6 trillion yen earmarked for public works, 1.2 trillion to expand loan quotas for small- and medium-sized businesses and 900 billion for the Japan Development Bank. The package passed in December, but investment kept falling and unemployment rose. By the end of the year, Japan's debt-to-GDP ratio was 68.6%.

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Now we're told that a similar spending program -- a new New Deal -- will revive the U.S. economy. How do you say "good luck" in Japanese?

GM had its best sales year ever in 2007. It sold over 9 million cars around the world — the same number as Toyota. But Toyota made $20 billion, and GM lost $40 billion. Their viability is not going to change if the cost structure is such that they cannot succeed. Until they restructure, we’d just be throwing good money after bad to prop them up for a few months.

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It is a dangerous and socialist idea that the government can intervene and guarantee outcomes. We can’t guarantee outcomes. And in fact, the reason we are in a financial crisis in our country is because of government involvement — such as the mismanagement of Fannie Mae. In the financial industry, for years, we forced banks to make loans to people who didn’t have good credit as part of a social-engineering strategy.

Likewise with the unions in Michigan. We’ve forced people to join unions in Michigan if they want to work for the auto industry, and thus we’ve forced them basically to fund a political party through their dues. They’re the only kind of organization that is given that kind of government protection. And so forced unionization, sanctioned by government, has essentially put the backs of these American auto companies to the wall. And now the government is going to come in and say we have to save them.

Government has been doing that on many fronts. Our policies create a crisis, and once there’s a crisis, we say we need to get the government more involved. We’re inching our way toward a European style of socialism. The auto bailout is just one more big step in the wrong direction.

• “Three, GM owes $23 billion to the United Auto Worker’s VEBA (voluntary employees’ beneficiary association) account. The union must agree to take half of that payment in GM stock.

• “Four, the union must agree to do away with payments to workers who are still receiving almost full compensation up to four years after their jobs have ended.

“These are the same types of conditions a bankruptcy judge might require to ensure that these companies become viable and sustainable into the future, and if they will agree to these terms then we have something to talk about. The process I have suggested would allow them to avoid the problems and stigma that accompany a formal bankruptcy, while forcing them to do the things they need to do to be successful companies.”